The day of the multibillion-dollar leveraged buyout seems past, but the firm of Kohlberg Kravis Roberts & Co. is on a roll. The $450 million initial public offering of its Duracell International unit was a hit with investors. KKR's publishing venture just acquired a $600 million basketful of magazines. And perhaps most important, KKR, along with Fleet/Norstar Financial Group Inc., is taking over the government-seized Bank of New England. The firm could become a major player in the reshaping of the troubled banking industry.
Yet now, a forthcoming book, The Money Machine: How KKR Manufactured Power & Profits, alleges that one of the most successful firms in financial history accumulated its vast wealth, in part, by gouging investors, juggling the books, and rewarding its friends with financial favor. Criticism of KKR in investment circles and in the press is not new. But this book, written by Sarah Bartlett, a reporter for The New York Times and a former BUSINESS WEEK editor, goes far beyond past critiques and presents a distinctly unflattering view of a firm more than willing to cut corners in pursuit of gain.
While Bartlett's probe finds plenty of smoke, it uncovers no smoking guns. Any violations of the law, she concedes, "would be difficult to prove in court." As Bartlett describes them, most of the ways in which KKR drums up business are, in fact, similar to the practices of other investment firms. KKR officials wine and dine clients and prospective clients. They make friends in high places with political contributions. They keep investment bankers eager to please by spreading KKR business around the Street. Moreover, she says, partner Henry R. Kravis charms the press masterfully--and the press, she adds, generally returns the compliments.
ACRIMONY. Yet some of KKR's alleged tactics go beyond what most people on Wall Street would consider proper. The book is sure to generate concern among KKR's primary investors--state pension plans for public employees--whom it claims KKR cheated out of millions.
KKR's allies are sure to point out that Bartlett's chief sources are far from disinterested. Many of the book's most incendiary charges are based on interviews with Jerome Kohlberg Jr., the firm's founder who left Kravis and George R. Roberts in 1987 in an acrimonious dispute over the firm's direction. In 1989, Kohlberg filed a lawsuit against his former partners that was eventually settled out of court. Kohlberg declined comment on the book except to say through a spokesperson that the work provided a fair and accurate description of what he told Bartlett.
Another source was Hedi Kravis, Henry's ex-wife and the mother of his three teenage children. She declined comment except to confirm she spoke for the record with Bartlett. Both she and Kohlberg, the author argues, have credibility because both had more to lose than to gain from speaking their minds.
KKR originally planned a rebuttal to the book. But a KKR spokesman now says: "We've read the book, and it doesn't merit a response." The Money Machine, which will soon be in bookstores, was excerpted in The New York Times Magazine on May 5.
LOWBALL OFFERS. Bartlett's most damaging charges relate to how KKR treated its investors, most of which are state pension funds. While KKR has made millions for its clients, Bartlett argues that it could have made a whole lot more--at least $750 million, she estimates--had the firm dealt with them fairly. KKR, she says, took advantage of its investors when it recapitalized companies that it controlled and repurchased shares from the investors.
In June, 1988, for instance, KKR recapitalized Marley Co. and offered to buy back investors' shares for $8 apiece--shares that cost $4.13 in 1981. That was not one of KKR's better deals. But, says Bartlett, in the two years following the buyback, Marley's earnings were 26% and 30% higher than the projections KKR had given the pension funds when it made them the offer. Kohlberg told Bartlett that his ex-partners could have paid shareholders at least 25% more.
In the case of the PacTrust buyback in 1988, she reports, KKR gave its pension-fund investors no choice: They had to tender their shares, at a price set by KKR, which, along with PacTrust management, wanted to own all the equity. That's a conflict of interest, she argues, and a breach of the firm's fiduciary duty to investors. KKR privately estimated at the time that its $2 million stake would be worth $36 million within five years.
Bartlett also alleges that KKR rewarded one key official of a state pension fund for investing in the firm's deals. She describes KKR's arrangement with Roger Meier, former chairman of the Oregon Investment Council, who was, she says, provided a sweetheart investment in U. S. Natural Resources Inc. after he had stepped down from the council. Meier, who served on the council from 1970 to 1986, was KKR's biggest booster, responsible for investing more than $300 million of the state employees' pension money in LBO deals. Oregon was also the first state pension fund to invest in KKR-sponsored funds, and its success--and Meier's endorsement--proved critical in enlisting other public pension funds, the source of most of KKR's power. Meier denied that he acquired his investment at "an advantaged price."
These allegations could hamper the buyout firm's current campaign to raise $2 billion for a new buyout pool. Already, KKR has met resistance from once-eager pension investors, mainly because of its high fees (BW--Apr. 15).
State pension officials were only some of the people whom KKR cultivated to build its power base. It also cut lawyers in on some deals. One was Richard I. Beattie, now senior partner at the Wall Street law firm of Simpson Thacher & Bartlett and one of KKR's lawyers. The author asserts he acted unethically by investing in KKR companies while acting as counsel on the deals, apparently without always informing his law partners. Bartlett says Beattie presented himself as a conciliator in several matters while really representing only Kravis' interests. Beattie's spokesman, who also represents KKR, gave the same comment: "The book doesn't merit a response."
And KKR cultivated the press. Bartlett criticizes Wall Street Journal reporter George Anders for covering KKR at the same time he has been writing a book about the firm with KKR's cooperation. (Bartlett says she did not cover KKR while working on her book.) She implies that influenced Anders' stories. She says Anders depicted the 1990 refinancing of KKR's $32 billion LBO of RJR Nabisco Inc. as a "great success story." But, she adds, that ignored the view of some investment bankers who saw it as a humiliating rescue operation. Favorable coverage in the Journal, notes Bartlett, is crucial to how deals are seen on the Street. Paul E. Steiger, deputy managing editor at the Journal, replies that "We were aware of George's work every step of the way and saw no conflict. The coverage was fair, well-sourced, and broke news."
'SATISFIED.' Will KKR be hurt by Bartlett's book? Many pension investors, long aware of criticisms of KKR, seem likely to stand by the buyout firm. Dan Grimm, the treasurer of Washington State, who has read the Times excerpt of the book, said the Washington State Investment Board recently reviewed its dealings with KKR with an outside consultant before voting to invest $350 million in KKR's new fund. Says Grimm: "We've been satisfied with the service and the results." Over the years, the pension system has, by its own count, reaped a 42% annualized return.
Yet there have also been negative repercussions from Bartlett's book. It has caused something of a stir in Oregon. State Senator Grattan Kerans, chairman of the Senate Labor Committee, has asked the state attorney general to investigate KKR's relationship with the Oregon Investment Council, which governs Oregon's $12.5 billion public-pension fund. "True, we made a lot of money with KKR," says Kerans. "But we could have made a whole lot more if everybody involved had met their fiduciary responsibility."
If many of KKR's investors come to the same conclusion, that could slow the company down. But don't bet on that quite yet. The firm's returns have so outdistanced the pension funds' other investments that, unless more damning charges emerge, most investors will likely keep on feeding KKR's munificent money machine.